Can inflation be beneficial

We would be simplifying the impact of inflation on business if we suggested that all effects were unfavorable. There is a school of thought, which argues that a low and stable rate of increase in the price level can be beneficial. It believes that a steady rise in money profits produces favorable expectations and induces investment as firms seek to expand. This action expands the economy as a whole. Paradoxically, inflation can also reduce the costs of businesses in the short run. Many enterprises incur costs, which are fixed for some period of time - for example, the rent of a factory may be fixed at a particular figure for a few years. At a time when the selling price of the firm's product, and hence its sales income, is rising this cost will be falling in real terms and thus stimulating the business.

There is a further argument that firms may be persuaded to borrow heavily in a period of inflation since the burden of repaying loans is reduced by inflation. If inflation is running annually at 10 per cent, for example, then the real value of the repayments of the loan will fall by approximately that amount each year. This may serve to encourage investment which, since it is an injection into the circular flow, will promote the level of activity. However, in these circumstances interest rates are likely to be high.

Government will accept that low rates of inflation are likely to exist in many economies. Inflation rates of 5 per cent or below are not considered to be too great a problem, especially if competitor nations are suffering similar rates.

In spite of the above, the conclusion must be drawn that inflation is, in general, harmful to business and its environment. Indeed, many economists would contend that inflation is the fundamental evil as its presence leads to lack of competitiveness and therefore relatively high unemployment and low rates of growth. This viewpoint has gained in credence in government circles over the last few years. It is for this reason that its control has been a major objective of government economic policy throughout the 1980s and early 1990s.